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February 20, 2014

Tax History: The Terrible, Horrible, No Good, Very Bad Filing Season of 1914

Joseph J. Thorndike

Filing season is never easy for anyone -- not for taxpayers and not for the IRS. This year, we've already heard a round of complaints about poor IRS service. The agency is struggling, taxpayers are frustrated, and Congress is outraged. However, 2014 is hardly different from any other year. Tax griping is perennial.

But some years really are worse than others. One particularly bad filing season came at the very start. A survey of press reports from February 1914 paints an unhappy picture.

Early Deadline

Congress enacted the modern income tax as part of the Revenue Act of 1913, which became law on October 3, 1913. In their wisdom, lawmakers established March 1 as the filing deadline for 1914 and every subsequent year. That gave the Bureau of Internal Revenue (BIR) -- and taxpayers -- just five months to get ready for the inaugural filing season.

From start to finish, the filing process looked different in 1914 than it does today. The deadline, of course, was earlier. By March 1, taxpayers were expected to complete the new "Form 1,040" (as it was then punctuated), reporting their income for the last 10 months of 1913 and calculating how much tax they owed.1

Payments, however, were not due March 1. Instead, each taxpayer's Form 1040 was first reviewed by the local collector of internal revenue and then forwarded to Washington for a second review at BIR headquarters. After the return's accuracy was established, collectors were required to submit a bill to the taxpayer by June 1. Final payment was due by June 30.2

Or at least, that was the plan. In fact, there was considerable confusion about the filing process, and especially about the deadline for filing returns. When lawmakers chose March 1 as the due date, they had failed to provide any flexibility for years in which that date fell on a Sunday. Years like 1914.

As the filing season got underway, official statements and newspaper reports confirmed that Sunday, March 1 was the date certain for filing returns.3 This implied that taxpayers had better wrap things up no later than Saturday, February 28 if they hoped to avoid penalties. But as the final deadline approached, a few observers questioned whether early filing was really necessary.

"There seems to be a wide-spread impression that because March 1 falls on Sunday, it will be necessary for all income tax returns to be filed in person or placed in the mail on Saturday," noted The Wall Street Journal on Friday, February 27. But in fact, taxpayers had already gotten a reprieve. Treasury regulations issued in early January provided for the wiggle room that Congress had forgotten. When March 1 fell on Sunday or a holiday, taxpayers would get an automatic one-day extension. In 1914, that meant returns would be due on Monday, March 2.4

Prospect of Evasion

The extra day was no doubt welcome, but it did little to assuage worries that tax day would still be a disaster. Observers were especially concerned that taxpayers would fail to meet their new responsibilities, either through deliberate evasion or simple negligence.

Evasion was the more serious problem, at least in prospect. The income tax had been hotly debated for years, and opponents continued to fight after it was on the books. Observers worried that some of these critics would simply refuse to file.

Congress had tried to nip this problem in the bud by establishing severe penalties for failing to file, while also providing ample enforcement tools. "A large appropriation has been made by Congress for the prosecution of persons who evade the law, and an example will be made of those who are caught," warned The Washington Post. "No one can say where the lightning may strike. The man who thinks he is safest in filing no return may be the very one who is detected."5

But detection and prosecution were only part of the battle. The Post's editorial writers mounted a moral campaign on behalf of compliance. "If the law is unjust or unnecessary it should be repealed," the Post continued. "But as long as it is on the statute books, it should be enforced to the letter." Cheating the tax collector was not a crime against government, which was only an abstraction. Rather, it was an affront to friends and neighbors.

"It is not easy to inculcate in the minds of some persons that violation of the tariff or income tax laws is as serious an offense as robbery or embezzlement," the paper declared. "They feel that theft from an individual brings suffering to the victim, but that theft from the government brings suffering to no one." But that was patently untrue. "Those who evade the law are not putting any burden on the government," the Post concluded. "They are merely robbing their fellow citizens."

Reality of Confusion

If evasion was the biggest problem in theory, confusion was the bigger concern in practice. As the filing deadline drew near, BIR headquarters was flooded with inquiries from anxious filers. Washington officials told their regional BIR colleagues to stop slacking off. "Nearly 100 clerks are engaged in the office of the commissioner of internal revenue answering questions," reported one newspaper. "The office is behind in its work, so an order went forth to collectors that letters asking for information which should be supplied by collectors in accordance with instructions and regulations furnished them, will be referred to collectors for reply and writers of the letters advised of the reference."6

But the local collectors' offices were already struggling with their own deluge. In Los Angeles, the BIR office had been packed with confused questioners every day since mid-February. Staff were working night and day to keep up with the flood of incoming returns, while also answering questions. "The present income tax law is so confusing to the ordinary taxpayer that assistance in the preparation of the income statement is almost necessary," the Los Angeles Times observed.7 "Scores of prospective taxpayers are in quest of information, and an elucidation of the enigma furnished by the various 'rulings' of the Treasury Department."8

The sources of taxpayer confusion were numerous. But according to a former BIR official -- recently embarked on a lucrative law practice specializing in income tax problems -- the biggest challenge was trying to figure out "where the personal expense ends and the business expense begins."9

Among the confused Californians was the local collector of internal revenue. "John P. Carter, in the role of private citizen, writhed in his chair in the Federal Building yesterday," reported the Los Angeles Times, "an expression of anguish on his face as he labored over the income tax return he is to make to himself as John P. Carter, Collector of Internal Revenue." Carter was at least avoiding the last-minute rush, completing his return with weeks to spare. But he was having a tough time of it. "Carter's brow was knit and corrugated -- the mental process incident to discovering 'the original source' of his wealth required about all the mathematics the citizen could master in making his report to himself as collector." Eventually, however, Carter beat his tax form into submission. "When last seen, he was sleeping soundly," the paper reported. "His physician said he would recover."10

Other government officials were also struggling to complete their forms. Alvey A. Adee, second assistant secretary of state, was reportedly "stumped." After studying the law and regulations, he told reporters, he was at a loss. "To be perfectly frank, I feel a good bit puzzled," he said.11

Last-Minute Rush

As a result of all the confusion (and, no doubt, procrastination), many taxpayers were running late. Returns started to pile up quickly as February drew to a close. In New York, the collector got special permission from Washington to keep his office open late at night on March 2. And he wasn't the only one burning the midnight oil. "The returns have come in so fast in the last few days that most of the Collectors have found it impossible to do more than stack them up and stow them away until the rush is over," The New York Times reported.12

Returns were coming in late in Los Angeles and Chicago, too. The Los Angeles Times estimated that only half of all required returns had been filed by March 1 in the local collection district. "The impression prevails that there will be a big delinquent list for someone to handle after the flag drops on the slow ones tomorrow," the paper reported.13

Wealthy taxpayers seemed especially slow to file. In Chicago, roughly 4,000 returns had been filed by February 28. But according to The Chicago Daily Tribune, "not a single return of the first magnitude was received." BIR officials disclosed that two or three taxpayers with incomes greater than $1 million were resident in the district. But none had yet filed their returns. "It is believed that lawyers in charge of preparing the schedules for Chicago's wealthiest men are holding back until tomorrow as a precaution against possible leaks," the paper reported.14

One taxpayer with an income of $750,000 did manage to file, reporting a tax liability of $42,516. But although the existence of this return was reported by BIR officials, the identity of the taxpayer was not. Which produced exactly the sort of speculation that you might expect. Some possibilities floated in the press included meatpacking magnate J. Ogden Armour, Sears Roebuck owner Julius Rosenwald, banker John J. Mitchell, grain merchant James A. Patten, or Richard T. Crane Jr., heir to the Crane manufacturing fortune. Whoever the taxpayer was, he was probably worth about $20 million, the paper said.15

In California, another guessing game surrounded the return of a previously undiscovered millionaire. Information released by the collector's office revealed that someone in the state's northern region had reported a 10-month income of $1.1 million. That figure likely ranked him among the 10 or 15 richest Americans, but this West Coast Croesus remained an enigma. "He is a man of mystery," the Los Angeles Times observed. "No other man west of Chicago is richer, it is believed."16

Problems in Paris

While Californians were trying to identify the millionaire next door, U.S. expatriates were struggling with a more immediate question: Where could they get their hands on a tax form?

Blank tax forms were slow to make their way across the ocean. The first (very small) batch arrived not through official channels but in the personal mail of an American banker. His New York colleagues had written (perhaps in early February, although the timing is unclear) to remind him that returns were coming due. "Do not forget to file your blank for the income tax," they told him. "You must do it personally. We cannot do it for you here." The bankers' colleagues assured him that the U.S. consulate would have "about a ton of the necessary forms." But just in case, they enclosed a few extras.17

In fact, the consulate had no forms on hand -- nor any knowledge of them, for that matter. The consul general, Alexander M. Thackara, was completely in the dark. "Blank 1040: what is that? I never saw one," he told a reporter. Thackara -- who was married to the daughter of William Tecumseh Sherman and known to his intimates as "Mont" -- soon grew worried about his own responsibilities. "I want one quick," he said. "I am a government employe [sic], so it is simply out of the question for me to be a single day late in filing my blank."18

Officials at the U.S. Embassy were just as clueless as their colleagues at the consulate. "In fact, no person, bureau, or society in any way in touch with the American Government had received any Government notification concerning the existence or the necessity for filing 'Blank 1,040,' although the first paragraph of the income tax statute says that a return shall be made by citizens of the United States, whether residing at home or abroad," The New York Times reported incredulously.19

Thackara eventually wheedled a blank out of a friend who happened to have an extra one. The ambassador got one from his bank. But for most Americans in Paris, the best they could do was wait. The official stock of forms did not arrive until mid-February, giving taxpayers little time to make the March deadline. "Practically all business other than filling out the blanks is at a standstill," the Times reported in mid-February. Nervous expatriates were apparently thronging bank lobbies "to the point of frenzy."20

The entire experience was trying, to say the least. "The American Government probably never before had such cruel criticisms from its sons who reside elsewhere," the Times concluded.21

Unhappy Bankers

Expats were not the only ones complaining, however. The financial community was in an uproar about withholding. We often think of withholding as a midcentury tax innovation that arrived during World War II. Which is mostly true. But lawmakers had actually experimented with some forms of withholding during the early years of the modern income tax, too.

It was not a happy trial, at least for the banks and other financial institutions that were charged with conducting it. Critics insisted that withholding was expensive for these companies, not to mention inconvenient. Indeed, a committee of disgruntled financial leaders created and distributed a special "form of protest," designed to be filed in conjunction with the official tax return.

The protest was not confined to administrative complaints about withholding. It began, in fact, with an attack on the income tax generally. In language only a lawyer could love, the form declared that:

The undersigned, who, under protest and duress, has (have) executed and verified the annexed "Return of Annual Net Income of Individuals," upon Official Form 1,040, as prescribed by the United States Treasury Department, protests (protest) against being required to make said return, and against its form, and against the assessment of any tax based thereon, or otherwise, against the undersigned under, or allegedly under, the provisions of Section II of the Act of Congress approved October 3, 1913, on the ground that the rights of the undersigned under the Constitution and/or laws of the United States are thereby violated.

The form went on to object specifically to the withholding provisions of the new law, although it emphasized not the inconvenience of the banker-withholder but the mistreatment of the taxpayer-withholdee. Withholding deprived the owner of the use of money before any tax was actually assessed; as such, it violated the Fifth Amendment. The form also suggested that decisions of the Treasury (reflected on the Form 1040) had expanded the income tax beyond the plain intent of the 16th Amendment. As a result, the actual law could not hide behind the amendment's shield against the Constitution's apportionment requirement. Even assuming that the tax were deemed indirect, rather than direct, it would still violate the Constitution because it was "arbitrary, unequal, not uniform throughout the United States, not within the taxing or other powers of Congress, and it is in conflict with the V. Amendment to such Constitution."22

Many observers thought the bankers were getting a little overheated with their rhetoric. But the withholding haters had support on Capitol Hill, particularly in the person of Rep. Joseph Moore, a Pennsylvania Republican with a seat on the House Ways and Means Committee. Moore introduced a resolution asking the committee to amend the new income tax law to require information at source, rather than collection at source.23 Bankers liked this idea, and they had been beating the drum for it since the law had been enacted. The Washington Post even thought withholding critics might have convinced a majority of lawmakers. (And the quick disappearance of withholding in the next couple of years suggests the paper was probably right.)

The Post's editorial page was clearly on the side of withholding foes. "Many concerns are compelled to pay the salaries of additional clerks merely to attend to this government work," the paper complained. "All banks are compelled to donate the services of their bookkeepers to the government for this government collection function."24

The paper acknowledged that some members of Congress -- and especially those who cherished the new income tax -- would resist any change to withholding. Once the door was open to a major revision of the law, who knew where the process might stop? "There have been so many objections to the working of the law, so many obscure points have been discovered, and so many books of explanations and regulations have had to be issued, that Mr. Moore's resolution might act as an opening wedge for a general revision and simplification of the law," the editors wrote. "An effort might even be made to make the law apply to all incomes, regardless of size, which would mean the repeal of the income tax law in double-quick time."25

Stay the Course

One person clearly worried about ill-advised efforts to reform the law was Rep. Cordell Hull, often described as the father of the income tax. On February 17 Hull released a defensive statement couched in a reassurance. Specifically regarding the collection at source of income on corporate bonds, Hull promised an administrative remedy. "Those connected with the drafting of the law had in mind a much more simple method," he said of the current procedures that were so irritating the bankers. Treasury was working on a solution that would be in place shortly, Hull promised.26

But Hull was adamantly opposed to any sort of legislative change to the withholding system. Made to work properly, withholding was eminently feasible. And proposed alternatives, like information at source, might prove even more burdensome for banks than withholding. "Information at the source would require greater detailed information from the banks handling coupons with respect to the identification of the bond, the debtor corporation, and the name and address of the actual bond holder, than would collection at the source in even its present form of administration," he said.27

Somehow, the banks muddled through that first filing season. But soon enough, they got their way about withholding. The world -- or at least the U.S. tax system -- was not ready for that particular innovation.

But the withholding fight was symptomatic of a larger problem that plagued the first filing season. Congress gave the country precious little time to get ready for its new income tax -- either mentally or practically. These days, the IRS complains about lead time whenever Congress dallies over tax legislation late into the year. But in 1913, Congress waited until October to declare that an entirely new tax system would be in operation just five months down the road.

That decree struck many observers as unwise. And the problems that surfaced in February 1914 confirmed the critics' worst fears. The BIR was not fully ready for the income tax when it made its March 2 debut. And neither was a nation of confused taxpayers.

FOOTNOTES

1 The partial year calculation was designed to ensure that only income earned after ratification of the 16th Amendment would be subject to the new tax. The amendment was formally certified by Secretary of State Philander Knox on February 25, 1913.

22 "Form of Protest on Income Tax," The New York Times, Feb. 5, 1914. For the corporate version of the protest, see "Fiscal Institutions Draw Up Protest for Corporations," The Wall Street Journal, Feb. 18, 1914.